UNCTAD/ITCD/TAB/11
UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT
POLICY ISSUES IN INTERNATIONAL TRADE AND COMMODITIES
STUDY SERIES No. 10
REGIONAL TRADE AGREEMENTS AND DEVELOPING COUNTRIES:
THE CASE OF THE PACIFIC ISLANDS’ PROPOSED
FREE TRADE AGREEMENT
by
Robert Scollay
APEC Study Centre
and
Economics Department, University of Auckland
New Zealand
UNITED NATIONS
New York and Geneva, 2001
NOTE
The views expressed in this study are those of the author and do not necessarily reflect the views
of the United Nations.
The designations employed and the presentation of the material do not imply the expression of any
opinion whatsoever on the part of the United Nations Secretariat concerning the legal status of any
country, territory, city or area, or of its authorities, or concerning the delimitation of its frontiers or
boundaries.
Material in this publication may be freely quoted or reprinted, but acknowledgement is requested,
together with a reference to the document number. A copy of the publication containing the quotation
or reprint should be sent to the UNCTAD secretariat:
Chief
Trade Analysis Branch
Division on International Trade in Goods and Services, and Commodities
United Nations Conference on Trade and Development
Palais des Nations
CH-1211 Geneva
UNCTAD/ITCD/TAB/11
UNITED NATIONS PUBLICATION
Sales No. E.01.II.D.16
ISBN 92-1-112527-8
ISSN 1607-8291
©
Copyright United Nations 2001
All rights reserved
ii
ABSTRACT
Fourteen of the world’s smallest and most vulnerable economies – the Forum Island Countries
(FICs) of the Pacific island region – are in the process of forming themselves into a free trade area
(FTA). This paper begins by reviewing the characteristics of the FICs and their external trade. It is
shown that despite their small size this is in many ways a very diverse group of economies. Standard
analysis of FTAs suggests that trade creation effects from a FIC FTA are likely to be small and that
there may be a substantial risk of trade diversion. Loss of tariff revenue is a major concern, which
needs to be addressed by restructuring of tax and tariff systems in some cases. Quantitative studies
have confirmed the small size of the trade creation effects and indicated the size of likely tariff losses,
but were somewhat reassuring on the issue of trade diversion. Studies have also highlighted the
importance of continuing attention to most-favoured-nation tariff reductions in parallel with the formation
of the FTAs in order to ensure that welfare effects are positive. A brief outline of the proposed FTA
is provided. The proposed FTA should not be evaluated as a “stand-alone” exercise but as part of a
wider process of gradually integrating the FICs into the global economy. It must also be seen in the
context of the FICs’ existing non-reciprocal free trade arrangements with Australia and New Zealand
and the European Union, and the prospective future development of those relationships on a reciprocal
basis.
iii
ACKNOWLEDGEMENTS
This paper was written while the principal author was a visiting scholar at UNCTAD’s Division
on International Trade in Goods and Services, and Commodities in Geneva. The support of the
Division and its Director, John Cuddy, is gratefully acknowledged. Grateful thanks are also due to Bijit
Bora and Lucian Cernat for their support and advice and for comments, and to an anonymous referee
for helpful comments on an earlier draft of the paper. Any remaining errors are of course the
responsibility of the author.
iv
CONTENTS
INTRODUCTION ...................................................................................................................1
I.
ECONOMIC CHARACTERISTICS OF THE FICs
AND THEIR TRADE..................................................................................................3
A.
B.
C.
D.
E.
F.
G.
H.
I.
II.
ISSUES IN DEBATES OVER RTAs –
RELEVANCE TO THE FIC FTA.............................................................................14
A.
B.
C.
D.
E.
F.
III.
Economic size and income levels...............................................................................3
Production structures................................................................................................5
Intra-FIC trade ........................................................................................................7
Trade with non-FICs................................................................................................8
Balance of trade.......................................................................................................9
Tariffs ....................................................................................................................10
WTO membership .................................................................................................10
Trade preferences ..................................................................................................12
Regional trade initiatives .........................................................................................12
The traditional Vinerian analysis ..............................................................................14
Tariff revenue.........................................................................................................16
Attraction of foreign direct investment .....................................................................17
Increased competition ............................................................................................17
Other arguments.....................................................................................................17
Conclusions ...........................................................................................................19
EVALUATION OF THE FIC FTA ...........................................................................20
A. Conclusions ...........................................................................................................22
IV.
THE FIC FTA PROPOSAL.......................................................................................24
V.
LINKS TO PREFERENTIAL ARRANGEMENTS WITH
DEVELOPED COUNTRY PARTNERS..................................................................26
VI.
CONCLUSION ..........................................................................................................29
REFERENCES ......................................................................................................................30
v
List of figures
1.
2.
3.
4.
5.
6.
7.
8.
Population of Forum Island Countries, 1993 or later ........................................................4
Nominal gross domestic product (1)................................................................................5
Nominal gross domestic product (2)................................................................................6
Nominal gross domestic product per capita......................................................................7
Trade with other FICs.....................................................................................................8
Ratio of total imports to total exports.............................................................................10
Tariff collections as percentage of imports......................................................................11
Tariffs as percentage of total tax revenue........................................................................11
List of tables
1.
2.
3.
Sectoral composition of GDP ..........................................................................................6
All countries: estimated changes in key economic variables.............................................20
Summary of results for FIC Free Trade scenarios ..........................................................21
Appendixes
1.
2.
3.
4.
Economic characteristics of the FICs: GDP, per capita GDP,
and population..............................................................................................................34
Tariffs FIC....................................................................................................................34
Notes on CGE modelling and results reported in Scollay (1998).....................................35
FIC exports and imports by destination and source........................................................38
vi
INTRODUCTION*
The proliferation of regional trading arrangements (RTAs) was a prominent feature of
the international trading system in the last decade of the twentieth century. The World Bank
(2000) notes that of the 194 agreements notified to the General Agreement on Tariffs and
Trade (GATT) or the World Trade Organization (WTO) since the GATT’s inception, 87
were notified in the years from 1990. Laird
(1999) notes that 45 agreements were notified
in the years from 1995 to 1998, with an estimated 62 further agreements which had not yet
been notified to the WTO by mid-1998. A new
survey by WTO (2000) counted a total of 172
RTAs currently in force with a further 68 under negotiation, some of which are designed to
replace existing RTAs.
Not surprisingly, these developments
have been accompanied by a lively debate on
the effects and implications of RTAs. There
are several strands to this debate. One strand
concerns the benefits and costs of RTAs for
their members, in comparison with other alternatives open to them. A related issue is the
effect of RTAs on non-members. A further area
of debate related to both these issues is the set
of questions regarding how RTAs can be designed to maximize benefits and minimize
costs. There is also a long-running debate over
whether the spread of RTAs threatens to undermine the multilateral trading system based
around the WTO, and a closely related debate
on whether the WTO’s disciplines and proce-
dures relating to RTAs are adequate to the situation. The implications, negative or otherwise,
of the tendency for RTA developments to centre around major trading nations has been a
particular focus of debate.
Developing countries have not stood
aside from the trend towards RTAs. Developing countries in all major regions of the globe
have been and continue to be participants or
potential participants in RTAs, and many participate simultaneously in several such agreements. The issues raised in wider debates have
naturally also been applied to the questions relating to the place of RTAs in the trade strategies of developing countries, and the contribution which participation in RTAs may make to
the development process.
Debate on this last point has a long history and not surprisingly the focus of the debate has tended to shift in line with changing
ideas on the relationship between trade and development. In earlier years, when the import
substitution paradigm heavily influenced thinking on development issues, proposals for RTAs
among developing countries often reflected an
interest in exploring a regional as distinct from
a national approach to import substitution,
through the creation of larger protected markets for the import-substituting industries to
exploit. More recently, as outward-looking
trade strategies have increasingly become the
norm, RTAs have tended more often to be
* On 28 June 2001, the trade ministers of the Pacific Islands Forum member countries announced that they had
endorsed a proposal for the establishment of a free trade area between the island country members of the Forum (the
Forum Island Countries, or FICs), to be known as the Pacific Island Countries Free Trade Agreement (PICTA). At the
same time they endorsed a proposal for a framework agreement, providing for the future strengthening at an appropriate
pace of trade and economic cooperation between all Forum members (including Australia and New Zealand), to be
known as the Pacific Agreement on Closer Economic Relations (PACER). These agreements will be recommended for
approval and signature to the Forum leaders, who will be meeting in Nauru in August 2001.
1
evaluated for their contribution to the more effective integration of their members into the
international economy. Debate also continues,
however, on the relation between trade and economic integration and the development of the
domestic economy, for example through improved infrastructure facilities.
This paper aims to make a modest contribution to debates surrounding participation
by RTAs in developing countries by considering the arguments commonly aired in these debates in the context of a specific proposal to
form a free trade area (FTA) among the island
nations of the South Pacific, the so-called Forum Island Countries (FICs), which made the
political decision in late 1999 to proceed with
the negotiation of an agreement on a FTA, referred to in this paper as the FIC FTA. In the
process it will be seen that the advantages and
disadvantages of a given RTA proposal need
to be assessed in the light of the economic characteristics of the participating countries and
their trade. It will also become clear that grasping the full implications of a proposal such as
FIC FTA requires an understanding of how the
proposed arrangement may interact with the
members’ trade relations with their major de-
2
veloped country economic partners.
The first section of this paper highlights
key economic characteristics of the FICs and
their major trading and economic relationships.
This is followed by a discussion of the factors
which are likely to be important in assessing
the benefits and costs of the proposed FIC FTA,
leading to some preliminary conclusions about
its likely economic effects. These conclusions
are then tested against some rudimentary quantitative analysis of the implications of the FIC
FTA, leading to some further conclusions about
FIC FTA’s likely economic effects and about
the way the agreement should be designed in
order to maximize benefits and minimize costs.
The main features of the proposed FIC FTA
are then outlined and briefly discussed in the
light of the conclusions from the preceding
analysis. A further section deals with the linkages between the FIC FTA proposals and the
existing trade agreements between the FICs and
their major developed country trading partners,
together with the complications which may
arise for the ongoing management of these existing arrangements in the context of the FIC
FTA proposal. This section is followed by a
brief concluding section.
I.
ECONOMIC CHARACTERISTICS OF THE FICS
AND THEIR TRADE
A central theme of this paper is that the
economic characteristics of the members of an
RTA and the characteristics of their existing
international trading relations have an important bearing on which issues are likely to be
important in assessing the role of the RTA in
their trade strategy, the likely benefits and costs
of the RTA, and possibly also on the likely balance between those benefits and costs. The
paper begins therefore with a brief review of
the economic characteristics of the FICs and
their existing trading relations. The data presented in this section of the paper were collected mainly from national statistics agencies
during visits to the FICs in the early part of
1998, and in each case are the latest data available at that time. In some cases the data are not
available in published form.
There are fourteen FICs in all: the
Melanesian States of Papua New Guinea, the
Solomon Islands and Vanuatu; the Micronesian
States of the Federated States of Micronesia,
Kiribati, the Marshall Islands, Nauru and Palau;
the Polynesian States of the Cook Islands, Niue,
Samoa, Tonga and Tuvalu, and the hybrid
Polynesian/Melanesian State of Fiji, which also
has a large Indian population. All fourteen of
these States are members of the Pacific Islands
Forum, which also includes as members Australia and New Zealand, which have strong traditional ties with the Melanesian and
Polynesian FICs (including Fiji) in particular.
The Pacific Islands Forum (formerly the
South Pacific Forum) provides a vehicle for
cooperation among the FICs themselves, and
between the FICs and Australia and New Zealand as the two developed countries of the
South Pacific. There is a somewhat uneasy balance, or tension, between these two roles. The
Forum Secretariat provides the FICs with technical and administrative support. For the FICs
the Forum is both an expression of the social
and cultural linkages extending far back into
their history, and a means of renewing, strengthening and deepening those linkages, as well as
building a foundation for closer economic relationships.
A. Economic size and income levels
The fourteen FICs are all extremely
small economies by international standards, but
at the same time there are also enormous variations among them in relative size. Figures 1
to 3 illustrate these points, and the data on
which these figures are based are shown as
appendix 1.
The total population of the fourteen
FICs is just over 6 million, of which 4.14 million and 0.75 million respectively are accounted
for by Papua New Guinea and Fiji. The population of individual FICs ranges from Papua
New Guinea’s 4.14 million to an estimated
2,300 in Niue. Three FICs (Niue, Nauru and
Tuvalu) have a population of less than 10,000,
and a further two (the Cook Islands and Palau)
have populations of between 10,000 and
20,000. While the land area of most FICs is
very small, large expanses of ocean separate
the FICs from each other, and in many cases
also separate the constituent islands of the individual FICs. One consequence of this oceanic separation is that most FICs have very large
Exclusive Economic Zones, and the marine
resources within these zones are among their
most valuable resources. On the other hand,
isolation, small size and susceptibility to natural disasters, as well as severe fluctuations in
3
Figure 1. Population of Forum Island Countries, 1993 or later
4500000
4000000
3500000
3000000
2500000
2000000
1500000
1000000
500000
0
PNG
F iji
S olomon S amoa
Is .
Vanuatu
F SM
the world prices of their main exports, are all
elements of the vulnerability of the FICs as
small island States.
In terms of economic size, available statistics indicate a total combined gross domestic product (GDP) of the fourteen FICs in the
mid-1990s of US$ 8,452 million. To put this
in perspective, this is approximately 13.5 per
cent of the GDP of New Zealand, the smaller
of the two developed country Forum members
and one of the smallest members of the Organization for Economic Co-operation and
Development (OECD). Of this total FIC GDP,
US$ 7,112 million, or just over 83 per cent,
was accounted for by Papua New Guinea and
Fiji alone. Figure 2 shows clearly the disparity
in economic size between these two economies
and the remaining 12 FICs. Figure 3, which
excludes Papua New Guinea and Fiji, allows a
more meaningful comparison of the economic
size of the remaining 12 economies.
The very small size of the combined FIC
market suggests that the potential for economic
4
T onga
Kiribati
Marshall Cook Is .
Is .
Palau
Nauru
T uvalu
Niue
gains based on economies of scale through
forming an RTA is clearly limited. Furthermore, small economic size is likely to be associated with severe limitations on availability
of administrative resources. A regional trade
arrangement which requires complex negotiations and administrative arrangements would
absorb a disproportionate share of those resources. It is unlikely that such an arrangement would be sustainable for the smaller FIC
economies.
There is also considerable variation in
income levels among the 14 FICs, as figure 4
indicates. The range in GDP per capita is from
US$ 8,204 in Palau to US$ 651 in Kiribati. This
represents a ratio of 13:1 between the highest
and lowest average income levels within the
FICs, comparable in fact to the corresponding
ratios within the European Union or the North
American Free Trade Area (NAFTA). It is
noteworthy that the two largest economies,
Papua New Guinea and Fiji, with per capita
GDP of US$ 1,111 and US$ 2,250 respectively,
are not close to either end of the range. Such
(7 per cent). The service sector accounts for
the largest share of GDP in most FICs. Services, excluding construction and electricity, gas
and water, account for over 70 per cent of GDP
in Palau (81 per cent), 79 per cent in Kiribati,
75 per cent in the Marshall Islands and 73 per
cent in the Cook Islands, and for between 50
per cent and 70 per cent of GDP in Tuvalu (67
per cent), Vanuatu (64 per cent), Fiji (54 per
cent) and Tonga (50 per cent). The services
sector share of GDP is relatively low in Papua
New Guinea (33 per cent) and Samoa (34 per
cent).
variation in income per capita may point to a
significant difference in relative costs of labour
and capital and in skill levels in the labour force,
and might normally be taken as an indication
of the potential for mutually beneficial trade to
take place.
B. Production structures
The summary data in table 1 on the
structure of production in a number of FICs suggest, however, that this conclusion should not
be accepted too readily. Production in these
economies is dominated by agriculture, forestry
and fishing. Agriculture, forestry and fishing
accounts for an especially large share of GDP
in the Solomon Islands (41 per cent), Samoa
(40 per cent) and Tonga (37 per cent). In most
other FICs the share is between 15 per cent and
27 per cent. In Papua New Guinea mining accounts for 27 per cent of GDP, in addition to
the 26 per cent accounted for by agriculture,
forestry and fishing. The share in GDP of agriculture, forestry and fishing is unusually low
in the Marshall Islands (13 per cent) and Palau
Manufacturing, on the other hand, has
not developed much in most FICs. The share
of manufacturing in GDP is highest in Samoa
(18 per cent) and Fiji (15 per cent), but the figure for Samoa is heavily skewed by a single
large enterprise which exists solely to supply
the Australian and New Zealand automotive
industries, taking advantage of preferential access available under the South Pacific Regional
Trade and Economic Cooperation Agreement
(SPARTECA). In all other FICs for which data
are available, manufacturing accounts for 5 per
Figure 2. Nominal gross domestic product (1)
5500
5000
4500
4000
US$ million
3500
3000
2500
2000
1500
1000
500
0
PNG
F iji
S olomon Vanuatu
Is .
F SM
S amoa
T onga
Palau
Marshall Cook Is.
Is .
Kiribati
Nauru
T uvalu
Niue
5
Figure 3. Nominal gross domestic product (2)
300
250
US$ million
200
150
100
50
0
Solomon Vanuatu
FSM
Samoa
Tonga
Palau
Marshall Cook Is.
Is.
Kiribati
Nauru
Tuv alu
Niue
Is.
cent of GDP or less, except for Papua New
Guinea (8 per cent). This suggests immediately that the range of manufactured goods that
are likely to be traded between the FICs in an
RTA is probably very narrow, with most of the
supply potential residing in a single FIC, Fiji.
The potential for trade in the agricultural, forestry and fisheries products which dominate
FIC production structures tends to be inhibited
by transport and quarantine problems, as well
Table 1. Sectoral composition of GDP (%)
Agriculture, forestry, fishing
Mining, quarrying
Manufacturing
Electricity, gas, water
Construction
Wholesale/retail,
restaurants, hotels
Transport, storage,
communications
Finance, insurance, real
estate, business services
Community/social/
personal services
Adjustments
Total
Source: National Statistics.
6
Cook
Islands
Fiji
Kiribati
21.0
0.0
2.6
2.9
1.2
19.4
3.3
14.8
4.1
4.5
17.4
0.0
0.9
1.2
1.8
20.1
16.5
10.4
Marshall
Islands
Solomon
Islands Tonga Tuvalu Vanuatu
Palau
PNG
Samoa
13.3
0.3
2.2
2.5
6.5
6.8
1.2
0.8
1.4
9.0
26.5
27.2
8.2
1.3
3.9
39.9
0.0
17.9
6.4
1.9
41.3
0.1
4.0
1.8
6.9
36.8
0.7
3.9
2.5
6.0
23.9
0.9
4.0
3.6
5.6
22.7
0.0
5.2
1.7
6.5
11.2
17.4
35.0
8.6
10.4
10.1
13.3
19.0
32.9
12.6
11.3
6.8
14.9
5.2
2.7
6.5
8.6
6.2
7.5
10.9
14.1
5.7
14.6
8.4
0.9
-
4.7
10.2
11.8
13.9
27.9
3.0
17.4
-6.7
36.9
13.6
34.4
2.0
21.6
0.9
13.1
5.1
20.8
0.0
23.9
0.7
22.6
-4.6
30.2
-5.1
11.6
-2.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
Figure 4. Nominal gross domestic product per capita
9000
8000
7000
US$
6000
5000
4000
3000
2000
1000
0
Palau
Cook Is.
Niue
Nauru
F iji
F SM
as by the fact that the FICs tend to produce similar products in these sectors.
Trade in services may offer a promising avenue for development of trade between
the FICs, and Forum leaders have in fact already expressed interest in extending the FIC
FTA to cover services. Service sectors such as
tourism may well benefit from closer integration among the FICs. At the same time, sensitivities relating to land ownership and ethnic
differences mean that issues such as right of
establishment and mobility of business persons
will have to be handled with great care.
C. Intra-FIC trade
An impression that the potential for
trade among the FICs may tend to be quite limited is reinforced by data presented in figure 5,
which shows the share of each FIC’s merchandise trade which is accounted for by other FICs
(imports, exports and total trade). It is clear
that trade between FICs (intra-FIC trade) accounts for only a very small share of the FICs’
total trade.
Marshall
Is .
T onga
Vanuatu
PNG
T uvalu
S amoa S olomon Kiribati
Is .
Specifically, the only FICs for which
trade with other FICs accounts for more than
10 per cent of total trade are Tuvalu (21 per
cent), Kiribati (18 per cent), and Samoa (13
per cent). For half of the FICs, trade with other
FICs accounts for less than 3 per cent of total
trade. These are the Solomon Islands (2.8 per
cent), Fiji (1.6 per cent), Nauru (1.3 per cent),
the Marshall Islands (0.8 per cent), Papua New
Guinea (0.6 per cent), the Federated States of
Micronesia (0.1 per cent) and Palau (0.1 per
cent). It is significant that the two largest FICs,
Papua New Guinea and Fiji, are both included
in this group.
Four FICs source more than 10 per cent
of their imports from other FICs: Tuvalu (21
per cent), Kiribati (20 per cent), Samoa (14 per
cent) and the Cook Islands (11 per cent). On
the other hand there are five FICs, including
Papua New Guinea and Fiji, which obtain 1
per cent or less of their imports from fellow
FICs: the Marshall Islands, Papua New Guinea,
Fiji, the Federated States of Micronesia and
Palau. The Solomon Islands and Nauru each
obtain between 3 per cent and 4 per cent of
7
Figure 5. Trade with other FICs
25%
Ex ports
Imports
Total
Percentage of total
20%
15%
10%
5%
0%
T uvalu
Kiribati
S amoa
Cook Is.
Niue
Vanuatu
their imports from other FICs. Exports to other
FICs do not account for more than 5 per cent
of the exports of any FIC. There are six FICs
for which exports to other FICs account for less
than 1 per cent of total exports: Papua New
Guinea, Nauru, the Marshall Islands, the Federated States of Micronesia, Palau and the Cook
Islands. There is also a group of six FICs for
which exports to other FICs account for between 3 per cent and 5 per cent of total exports: Vanuatu, Tonga, Kiribati, Fiji, Tuvalu and
Samoa.
Taken together with the narrow production base in most FICs, this information clearly
indicates that intra-FIC trade is unlikely in the
foreseeable future to account for more than a
small share of total FIC trade, even if it increases substantially as a result of the establishment of a free trade arrangement among the
FICs. In addition to trade barriers, the low level
of intra-FIC trade of course also reflects the
existence of other significant obstacles to this
trade, particularly the high costs of transporta-
8
T onga
S olomon
Is .
F iji
Nauru
Marshall
Is .
PNG
F SM
tion among the FICs, related both to their small
size and to the large distances separating them
from each other.
D. Trade with non-FICs
Data on the relative importance to the
FICs of different import sources and export
destinations are presented in the graphs in appendix 4. The data are for the latest year for
which the data could be obtained in the case of
each FIC. They show that FIC imports are
highly concentrated on long-standing traditional sources. Australia and New Zealand together account for over 90 per cent of the imports of Nauru and Niue respectively, and 78
per cent of Cook Island imports. They also
account for between half and two thirds of the
imports of seven other FICs: Tonga (67 per
cent), Samoa (60 per cent), Vanuatu (55 per
cent), Fiji (54 per cent), Kiribati (54 per cent),
the Solomon Islands (50 per cent) and Papua
New Guinea (56 per cent). In Micronesia there
is also a dominant supply source – the United
States – which accounts for 51 per cent of imports into the Marshall Islands and 40 per cent
of the imports of the Federated States of Micronesia.
Exports are much more diversified.
New Zealand dominates the exports of Niue
(98 per cent), but beyond that Australia and
New Zealand account for more than 50 per cent
of exports only in the case of Samoa (57 per
cent), with their share of Cook Island exports
being slightly below 50 per cent at 47 per cent.
The two countries also enjoy a moderate share
of the exports of Fiji (24 per cent) and Papua
New Guinea (26 per cent). Beyond that there
are relatively small shares of the exports of
Tonga (18 per cent), Kiribati (9 per cent) and
Vanuatu (5 per cent).
There is also considerable variation
among the FICs in the relative importance of
other export markets. Japan dominates the
exports of the Federated States of Micronesia
(78 per cent), Palau, and Tonga (50 per cent),
and accounts also for a significant share of the
exports of the Solomon Islands (36 per cent),
Papua New Guinea (17 per cent), Vanuatu (16
per cent) and the Cook Islands (15 per cent).
The European Union accounts for large shares
of the exports of Kiribati (57 per cent), Fiji (26
per cent), the Solomon Islands (25 per cent),
Vanuatu (22 per cent), Samoa (21 per cent) and
Papua New Guinea (15 per cent). The United
States has a significant share of the exports of
the Cook Islands (25 per cent), Tonga (18 per
cent), Fiji (13 per cent) and Kiribati (13 per
cent). Other significant markets are the Republic of Korea for the Solomon Islands (15
per cent of total exports) and Bangladesh for
Vanuatu (30 per cent of total exports).
The variable importance of Australia
and New Zealand as export markets for the FICs
is interesting in the light of the common access to these markets which the FICs have enjoyed under SPARTECA. This variability will
reflect a mix of various factors affecting the
ability of the individual FICs to competitively
supply products to the two markets, as well as
the relative attractiveness of other markets.
This experience may be an indication that there
will be similar variability in the ability or inclination of the FICs to exploit opportunities
arising from establishment of free trade among
themselves.
E. Balance of trade
All but three of the FICs (Papua New
Guinea, Solomon Islands and Nauru) have a
deficit in merchandise trade. The ratio of merchandise imports to merchandise exports for
individual FICs is shown in figure 6. For those
FICs with merchandise trade deficits the ratio
of imports to exports ranges from 636:1 and
40:1 respectively for Tuvalu (not shown in figure 6, and excluding re-exports) and Niue to
1.6:1 for Fiji. In addition to Niue, there are
five FICs for which the ratio is between 10:1
and 5:1 (Cook Islands, Samoa, Kiribati, Tonga
and Palau). The ratio is between 5:1 and 3:1
for Vanuatu, the Federated States of Micronesia
and the Marshall Islands.
The balance on services trade should of
course be considered as part of the overall balance of trade, but unfortunately this information is not available for all FICs. Six FICs (Fiji,
Kiribati, Samoa, Palau, Tonga and Vanuatu)
enjoy surpluses on their services trade. In none
of these cases is the surplus on services trade
sufficient to offset the merchandise trade deficit. Fiji and Palau have the largest surpluses on
services trade relative to the size of their merchandise trade deficits. Papua New Guinea,
the Solomon Islands, Tuvalu and the Federated
States of Micronesia all have deficits in their
services trade. The services trade deficits of
Papua New Guinea and the Solomon Islands
are large relative to their merchandise trade
surpluses, and in the latter case result in an
overall trade deficit. The services deficits of
Tuvalu and the Federated States of Micronesia
are additional to substantial deficits in merchandise trade.
9
Figure 6. Ratio of total imports to total exports
45
40
35
30
25
20
15
10
5
0
Niue
Cook Is. Samoa
Kiribati
Tonga
Palau
Vanuatu
FSM
Marshall
Is.
F.
Tariffs
Figure 7 shows FIC tariff revenues as a
percentage of imports. This provides an implicit measure of the average tariff actually
applied to imports in each FIC. This implicit
average tariff rate is considerably lower than
might be expected on the basis of published
tariff schedules in most cases, reflecting substantial undercollection of tariffs. The reasons
for undercollection in a number of FICs have
been detailed in recent tariff studies by the Forum Secretariat.
Figure 8 shows tariff revenues as a percentage of total tax revenues in the FICs. This
clearly indicates the importance of tariff revenues in the tax base of most FIC economies,
although as noted later in this report many FICs
are moving to implement tax reforms which
will result in a lower share of total tariff revenue being provided by tariffs in the future. The
impact of a FIC free trade arrangement on tariff revenues depends on the proportion of total
trade which will be affected and the distribution of that trade across different tariff classes.
10
Fiji
Solomon
PNG
Nauru
Is.
More complete information on FIC tariff rates
is provided in appendix 2.
G. WTO membership
Three FICs – Fiji, Papua New Guinea
and the Solomon Islands – are members of the
WTO, and a further three – Samoa, Tonga and
Vanuatu – have applied for membership. This
is enough to ensure that any RTA involving
these FICs will have to comply with relevant
WTO obligations. In the case of an RTA involving only FICs it can be sufficient to meet
only the relatively undemanding requirements
of the “Enabling Clause”, which essentially
provides a dispensation from normal WTO
rules for various trade arrangements involving
developing countries, including RTAs. An RTA
including developed country members, on the
other hand, must satisfy the requirements of
Article 24 of the GATT, which is now part of
the WTO Agreement, together with the “understanding” on its interpretation incorporated
into the Final Act of the Uruguay Round. If
the RTA also covers services trade it must com-
Figure 7. Tariff collections as percentage of imports
35
30
25
20
15
10
5
0
Vanuatu
Kiribati
S amoa
T onga
PNG
F iji
S olomon
Is .
ply in addition with Article V of the General
Agreement on Trade in Services (GATS). Forum economic ministers have clearly stated a
commitment to implement policies consistent
with WTO principles wherever possible. This
T uvalu
Cook Is.
Niue
Marshall
Is .
Palau
F SM
Nauru
may be interpreted to imply that a FIC FTA
should not necessarily rely on a dispensation
under the Enabling Clause but rather aim to
meet the higher standards required under Article XXIV.
Figure 8. Tariffs as percentage of total tax revenue
70
60
50
40
30
20
10
0
Kiribati
Vanuatu Tuv alu Marshall Samoa
Is.
Fiji
Tonga
Solomon
FSM
PNG
Palau
Cook Is.
Is.
11
H. Trade preferences
The FICs have historically enjoyed nonreciprocal trade preferences from their major
trading partners under a wide range of agreements, the most important of which have been:
•
The Generalized System of Preferences
(GSP), which is made available unilaterally by
developed countries to all developing countries,
although the product coverage varies between
developed country markets;
•
The Lomé Convention, which provided
preferential access to the European Union,
along with a range of other benefits for all FIC
members of the ACP (African, Caribbean and
Pacific) group of States. Until recently this
group excluded the Federated States of Micronesia, the Marshall Islands, Palau, Nauru, Niue
and the Cook Islands. With the signing in 2000
of the Cotonou Agreement to replace the Lomé
Convention, these six FICs have also become
members of the ACP group;
•
The compacts of Free Association (CFA)
with the United States, which provides trade
access privileges, as well various important
entitlements to financial assistance, for the Federated States of Micronesia, the Marshall Islands and Palau;
•
SPARTECA, which provides duty-free
access to the Australian and New Zealand markets provided that rules of origin requirements
are met;
•
The Papua New Guinea Australia Trade
and Commercial Relations Agreement
(PATCRA), which is applicable only to Papua
New Guinea.
These preferences are being heavily
eroded as the preference-granting countries reduce their trade barriers in pursuit of both multilateral and unilateral trade liberalization objectives. There is also increasing pressure for
existing non-reciprocal preferential trade agreements with developed country partners to be
12
replaced by reciprocal arrangements. The European Union has proposed that the non-reciprocal arrangements applying under the former
Lomé Convention should be replaced by reciprocal arrangements embodied in a Regional
Economic Partnership Agreement (REPA), although it has left open the possibility that another format could be adopted (Commission
of the European Communities, 1997). The
Cotonou Agreement is designed as a transitional arrangement, allowing time for new permanent arrangements to be negotiated. It provides for negotiations on the new arrangements
to begin in 2002.
It is noteworthy that among the preferential regional trade agreements in which FICs
participate, only SPARTECA and the Cotonou
Agreement include all 14 FICs in its membership.
I.
Regional trade initiatives
There are also a number of preferential
regional trading initiatives within the FIC
grouping. The most developed of these is the
trade agreement of the Melanesian Spearhead
Group (MSG), which originally involved three
members of the MSG – Papua New Guinea,
Solomon Islands and Vanuatu – and has more
recently been extended to include Fiji. The
members of the MSG trade agreement have
agreed to eliminate tariffs on trade between
themselves for an agreed list of products
(Grynberg and Kabutaulaka 1995). Initially,
only a very small number of products was included in this agreement, but subsequent negotiations have progressively expanded the
range of products covered, which nevertheless
remains quite restricted. While anecdotal evidence indicates some success in expanding
trade within the MSG group, the level of this
trade remains low. The MSG trade agreement
does have a political significance in the context of the FIC FTA, in that it envisages the
assertion of a distinct Melanesian identity, as
against the Forum-wide concept embodied in
the proposed FIC FTA.
Fiji also has long-standing non-reciprocal trade agreements with Kiribati and Tuvalu,
and a more recent reciprocal agreement with
Tonga, in addition to its arrangements with the
other MSG members. Like the MSG trade
agreements, Fiji’s bilateral trade agreements are
all “positive list” agreements, which means that
they apply only to a specified list of products.
These lists are generally rather short, particularly in the case of the bilateral agreement with
Tonga, which covers only a small number of
products. Short lists may reflect a reluctance
to commit to meaningful liberalization, although it could also reflect a relatively small
portfolio of products of export interest.
13
II.
ISSUES IN DEBATES OVER RTAS –
RELEVANCE TO THE FIC FTA
The FICs have already accepted the
need to participate in the worldwide trend towards freer trade by progressively liberalizing
their trade policies. The appropriate way to
evaluate the FIC FTA proposal is therefore on
the basis of the contribution it can make to the
adoption of more liberal trade regimes, and to
the capturing of the economic benefits that can
be expected to follow from reductions in trade
barriers.
Over the years a considerable number
of factors have been proposed as having a considerable bearing on whether RTAs are likely
to be beneficial for members, the extent of any
negative effects on non-members, and whether
RTAs tend to undermine or support the multilateral trading system. Reference to the economic characteristics of the FICs can help to
identify those arguments which are more relevant and less relevant in the case of the proposed FIC FTA.
A. The traditional Vinerian analysis
Viner (1950) provided the essential insight that programmes for the removal of trade
barriers that might unequivocally improve the
welfare of the implementing country if implemented on a unilateral or multilateral basis, will
not necessarily do so if implemented on a preferential basis. As is well known, this is because RTAs and other preferential agreements,
by discriminating in favour of their members,
must inevitably discriminate against non-members.
The essential logic of trade liberalization is that countries benefit by importing goods
and services which they are relatively ineffi-
14
cient at producing themselves, in exchange for
the goods and services which they can produce
relatively efficiently. When trade liberalization
is undertaken on a most-favoured-nation
(MFN) basis, either unilaterally or multilaterally, these efficiency gains are ensured because
the increased imports will come from the most
efficient international source, and the increased
exports will be of products in which the liberalizing country is internationally competitive.
MFN liberalization is thus a first-best policy.
Preferential trade agreements do enable
members to enjoy gains from trade. Members
of such agreements will increase imports of
goods and services which their partners can
produce more efficiently, and increase their own
exports of goods which they themselves can
produce more efficiently than their partners.
This increase in trade is the trade creation effect of a free trade area, and confers economic
benefits in the same way as the increase in trade
resulting from non-discriminatory trade liberalization. The gains from trade in a preferential trading arrangement will, however, generally be less than the gains available from a corresponding reduction of trade barriers on a nondiscriminatory basis, since such arrangements
are unlikely to include the most competitive
suppliers of all goods and services in their
membership. This is especially likely to be true
of free trade areas involving small groups of
countries, particularly if those countries are
themselves small.
Second, the gains from trade creation
in a preferential trade arrangement can be partly
or wholly negated by an effect called trade diversion, which does not arise in the case of nondiscriminatory trade liberalization. Trade diversion occurs when the preferences created
under the arrangement cause imports to be
switched from non-partner to partner countries,
even though they are available from the nonpartner countries at a lower cost. This can happen of course because the higher-cost goods
from the partner country enter free of duty and
other restrictions under the free trade agreement, which may allow them to be sold to customers at a lower price than the lower-cost
imports from the non-partner, to which duties
and other restrictions continue to be applied.
Although consumers may benefit from lower
prices, the resource cost to the importing country of acquiring the goods, as measured by the
foreign exchange outlay needed to pay for them,
has increased.
The potential for negative effects comes
about as a result of the violation of the nondiscrimination principle, which inevitably
means that regional trade liberalization is a second-best economic policy. Whether the economic effects of second-best policies are positive or negative generally depends on the facts
of each particular case, and this is indeed the
case with RTAs. The conventional analysis of
preferential trading arrangements such as free
trade areas and customs unions indicates that
they may either benefit or harm their members,
depending on whether trade creation outweighs
trade diversion or vice versa. In part the relative size of trade creation and trade diversion
effects depends on the design of each agreement, but it can also be related to economic
characteristics of the proposed members and
the structure of their international trade.
Laird (1999) reports the general view
that the prospects for maximizing trade creation and minimizing trade diversion will be
greater the larger the shares of the members’ in
their partners’ pre-existing trade, the larger and
more diversified the partners’ economies, the
closer the partners’ domestic prices to world
prices, and the greater the initial non-uniformity of the partners’ tariff structures. It is quite
clear that none of these characteristics, with the
possible exception of the last, are found among
the FICs.
Rather, the small size and very narrow
production base of the FIC economies, together
with the low levels of existing intra-FIC trade
and the limited potential for increasing it, suggest that the potential for trade creation in a
FIC RTA would be quite small. On the other
hand, the relatively high tariffs found among
the FICs means that the margins of preference
created in favour of the members in a FIC RTA
could be very substantial, with the corresponding danger that a significant part of any increased trade under such an arrangement would
constitute trade diversion rather than trade creation. Taken together, these factors suggest that
the welfare effects of a FIC RTA are likely to
be very small, and there is a very real question
as to whether they are likely also to be negative, owing to a preponderance of trade diversion over trade creation effects.
In any RTA the size of potential trade
diversion effects can be reduced if the partners
continue to reduce their external trade barriers
(i.e. trade barriers applying to imports from
non-members) on an MFN basis at the same
time as they eliminate trade barriers between
each other. Where the apparent risk of trade
diversion is high, as in the FIC case, this accompanying MFN liberalization is an especially
important condition for increasing the likelihood that the welfare effects of the RTA will
be positive. At the same as it ensures enhanced
welfare benefits for the members of the RTA,
this MFN liberalization helps to limit the negative impact on the exports of internationally
competitive non-members, and thus also helps
to tilt the balance of global welfare effects towards the positive side.
MFN liberalization in isolation, of
course, is the first-best policy and would produce unambiguously positive welfare effects
because of the absence of any potential for trade
diversion. One can readily hypothesize that the
superiority of this option in terms of overall
welfare effects is likely to be particularly pronounced in the case of the FICs. One could
also hypothesize that an RTA which includes
some of the FICs’ principal import sources,
15
such as Australia and New Zealand, would be
likely to generate less trade diversion and would
accordingly yield superior welfare benefits to
the FICs compared with an RTA limited to the
FICs themselves.
B. Tariff revenue
The heavy dependence of the FICs on
tariffs as a revenue source for their Governments is also quite clear, as is the fact that no
Government can contemplate a sudden collapse
in its revenue base. This is therefore a major
potential constraint on trade liberalization by
the FICs.
One solution, of course, is to restructure tax systems so as develop alternative
sources of revenue and thus reduce the dependence on tariffs for revenue purposes. The FICs
are aware of this and most are either moving or
have plans to move in this direction. Several
have introduced a value-added tax as a means
of broadening their revenue base, and others
are contemplating the introduction of either a
value-added tax or some other broad-based
consumption tax. In addition, improvements
in tariff administration and modernization of
customs procedures can be and are being made
to improve the revenue flow derived from any
given tariff structure, for example by reducing
the extent of under-collection of tariffs.
Restructuring of tax and customs systems is thus one of the major adjustments –
perhaps the major adjustment – that the FICs
are required to make to accommodate a liberalizing trade strategy. The time needed for this
adjustment is likely to be a major limiting factor for the speed with which the FICs are able
to undertake trade liberalization. Furthermore,
the adjustment will be greater the more comprehensive the liberalization, since this will
imply a correspondingly large loss of tariff revenue. There is thus a clear inverse relation between the size of the welfare gains to be expected from any given liberalization and the
size of the adjustment that must be undertaken.
16
An initiative such as a FIC FTA would be expected to produce small, possibly negative
welfare effects, but at the same time would have
a relatively minor impact on tariff revenue collections. The more comprehensive liberalization involved in an RTA including a major trading partner may be projected to yield much
larger welfare gains, but it will also cause a
much larger loss of tariff revenue, and both effects would be further accentuated in a move
to free trade on an MFN basis. The more complete the liberalization, the larger the adjustment, and the longer the period of time likely
to be needed to make that adjustment.
There is also the issue of the economic
meaning for countries such as the FICs of removing tariffs if the tariffs must be replaced
by alternative taxes of equivalent revenue-generating capacity. The advantage of a broadbased tax such as a value-added tax is that it is
neutral as between imports and domestic production. In addition, it is relatively easy to zerorate exports and thus remove the bias against
exports which derives from the effect of tariffs
on domestic cost structures, without any need
for recourse to complicated and administratively onerous drawback schemes. In such
cases the removal of tariffs still confers an economic benefit which follows from the removal
of their distortionary effects.
This argument is less convincing under
the conditions that exist in some of the smaller
FICs, where exports are negligible or even zero,
and where almost all consumption is importbased. In these cases the replacement of the
tariff by a value-added tax or similarly broadbased consumption tax may have little practical significance except as a formal prerequisite for participation in trade agreements which
require the removal of tariffs. The fact that
exports are negligible does not, however, mean
that they are not being inhibited by the presence of tariffs. It is still possible that the removal of the anti-export bias inherent in the
tariff could lead to the development of some
export potential.
C. Attraction of foreign direct investment
Ethier (1998) argues that the importance
of the traditional Vinerian analysis has been
overtaken by the new role of RTAs as the means
by which small countries seek to compete with
each other to attract foreign direct investment
(FDI). It is certainly true that the desire to attract FDI has been an important motivation for
the formation of some recent RTAs among developing countries, notably the Association of
South-East Asian Nations (ASEAN) and indeed also for the participation of developing
countries in RTAs with developed countries,
for example Mexico’s participation in NAFTA.
It is certainly true also that the FICs, in common with other developing countries, see an
increase in FDI as a hoped-for consequence of
their economic reform programmes, of which
trade liberalization forms an important part.
It is tempting to suggest that the formation of a FIC FTA may lead to an increase in
FDI by creating a larger potential market than
that offered by individual FICs. This suggestion must be tempered, however, by recognition that even in combination the FICs comprise a very small market in international terms,
and that the physical obstacles to trade between
the FICs will remain significant, even if all trade
barriers are removed, as noted earlier. It is thus
not realistic to expect that a FIC FTA will lead
to a quantum leap in FDI into the FICs. The
effect may be positive, but it is likely to be relatively small. The most noticeable impact may
be on the investment strategies of firms within
the FICs themselves, rather than of larger multinational operations that tend to be seeking
larger markets.
D. Increased competition
Reductions in X-inefficiency and elimination of monopoly rents due to increased competition are traditionally identified as sources
of economic gain in RTAs, and in some circumstances these effects have been argued to
be quite large relative to other sources of ben-
efit. The tiny size of FIC markets means that
the number of domestic suppliers to many markets will be very small. It is easy to envisage
that a producer in, say, Tonga, faced with the
prospect of greater competition from a counterpart in, say, Samoa, may be motivated to increase the efficiency of his or her operation.
Thus to suggest that this may be a possible
source of gain from the FIC FTA seems quite
reasonable. Again, however, the gain is likely
to be very small, because the number of markets for tradeable goods in which local producers are significant suppliers is relatively small.
E. Other arguments
A consideration of the economic characteristics of the FICs and their trade leads quite
reasonably to the suggestion that many of the
other, sometimes very sophisticated ideas and
arguments advanced to indicate possible economic benefits from the formation of RTAs will
be either irrelevant or at best of marginal importance to the analysis of a FIC FTA. Thus,
for example, the tiny size of even the combined
FIC market is unlikely to provide significant
opportunities for exploitation of economies of
scale, especially given the fact that a FIC FTA
cannot affect the geographical isolation of each
individual FIC. It is quite clear also that the
FICs are not “natural trading partners” in the
sense intended by Krugman (1991). They do
not trade intensively with each other and their
geographical proximity to each other is more
apparent than real as an economic factor; any
positive effect is likely to be nullified by the
high transport costs for freight between small,
widely separated islands. In any event, of
course, Bhagwati and Panagariya (1996) have
severely criticized the notion that geographical proximity provides a separate argument in
favour of the creation of an RTA.
The “non-traditional arguments” identified (and discounted) by Panagariya (1999),
such as guaranteed access to markets and shelter from contingent protection, are likewise of
little moment in the case of a FIC FTA. Any
17
markets to which guaranteed market access is
likely to be of importance to the FICs lie in
their developed country economic partners
rather than in their fellow FICs, and likewise
contingent protection, to the extent that it is a
problem for the FICs at all, is likely to affect
them only in developed country markets. The
economic effects of a FIC FTA are likely to be
too small for it to have any significance in
“locking in reforms”, another possible “nontraditional benefit” identified in Panagariya
(1999). The exception to this comment is that
the dependence of some FIC Governments on
tariff revenue is so great that even the introduction of a FIC FTA may be sufficient to trigger far-reaching reform of tax systems in some
FICs, and these reforms are likely to be irreversible.
Lawrence (1997) suggests that the creation of free trade areas tends to lead to encouragement for deeper integration. Whether this
should be counted as a benefit depends of
course on whether the integration arrangement
is itself welfare-enhancing. Deeper integration
involving the harmonization of policies may
not be welfare-enhancing if the policy differences being harmonized actually have a sound
economic rationale. In any event, there are significant obstacles to most forms of deeper integration among the FICs, although ambitions
in that direction clearly exist in the case of at
least some FICs.
On the other hand, the trade facilitation
measures which increasingly accompany the
liberalization packages in RTAs do typically
yield enhanced welfare benefits. Scollay (1998)
argues that if trade facilitation measures were
included in a FIC FTA, they could well be the
largest source of economic gain from the arrangement. The dominant share of agriculture
and fisheries in the production structures of
most FICs, together with the underdeveloped
state of quarantine services in the region, suggests that facilitation measures in the quarantine area might be particularly effective in encouraging growth in beneficial trade.
18
Customs procedures are another trade
facilitation area where substantial improvement
is possible. Although arrangements for cooperation exist between the FICs in both the quarantine and customs areas, Scollay (1998) identifies a number of ways in which this cooperation could be substantially enhanced.
Liberalization of trade in services is
another aspect of deeper integration that might
well be considered at a fairly early date as a
useful extension of a FIC FTA, as noted earlier.
Given the tiny size of the FICs, a FIC
FTA will clearly have minimal economic effects on non-members. Terms-of-trade effects
will be non-existent and although the risk of
trade diversion may be significant for the FICs
themselves, it will of negligible economic consequence for their trading partners. FIC FTA
will clearly not have anywhere near enough
economic significance to strategically affect the
behaviour of other countries in the multilateral
trading system, although it may have some significance for the FICs’ own trade relations with
their major developed country economic partners, as discussed later. It is sometimes argued
that RTAs may impede unilateral or multilateral liberalization by creating vested interests
that benefit from the preferences granted in the
regional arrangement. However, given the
likely minor trade effects of a FIC FTA, any
vested interests created by its formation are
unlikely to be large enough to seriously affect
trade policy in the FICs, let alone have any consequences for multilateral liberalization.
One possible negative effect of an RTA
identified in Panagariya (1999) is that members of an RTA may be tempted to raise MFN
tariffs to compensate for revenue lost due to
the formation of the RTA. This policy is likely
to be at least partly self-defeating, since raising MFN tariffs would tend to encourage further switching of imports to the RTA partners.
In any event, the fact that the FICs already appear to be moving towards restructuring their
tax systems to ensure sustainability of govern-
ment revenue in the face of trade liberalization,
combined with their recognition of the importance of their ongoing commitment to MFN
trade liberalization to their overall economic
welfare, means that it is also probably safe to
discount this possibility.
F.
Conclusions
The conclusions from this section are
quite clear. While there may be some minor
economic benefits associated with increased
competition and encouragement of FDI, analysis of the benefits and costs of a FIC FTA reduces in very large measure to the traditional
Vinerian concerns with the relative size of trade
creation and trade diversion effects, set against
the constraints created by the FICs’ dependence on tariff revenue. Trade facilitation is the
other area where substantial economic benefits
are possible, with services trade offering perhaps further opportunities in the future. There
is also an important question as to how far an
arrangement such as a FIC FTA serves as an
effective “stepping stone” to wider liberalization with greater potential for positive welfare
effects. However, suggestions that the Vinerian
analysis has lost its relevance are clearly premature, to say the least, in the case of economies such as the FICs.
19
III.
EVALUATION OF THE FIC FTA
Scollay (1998) reports the results of
some rudimentary computable general equilibrium (CGE) simulations carried out to test some
of the hypotheses identified in the previous
section regarding the economic effects of a FIC
FTA. A summary of the results of these
simulations is given in table 2. Similar
simulations, using essentially the same data set,
were performed by Stoeckel et al. (1998) for
an FTA including Australia and New Zealand
as well as the FICs; and, finally, Scollay and
Gilbert (1998) report the extension of the simulation exercise to consider full MFN liberalization by the FICs. For comparison purposes
the principal results from these three studies
are shown together in table 3.
Although widespread and serious data
deficiencies meant that construction of the
models used in these simulations was very timeconsuming, they are nevertheless very crude.
The crudeness of the models and the serious
deficiencies in the data on which they are based
preclude any serious weight being given to the
particular numbers generated in the
simulations. At best the results provide some
potentially useful information on the direction
and order of magnitude of economic effects.
Table 2. All countries: estimated changes in key economic variables
Percentage
change in
imports from
FICs
Cook Islands
Federated States of Micronesia
Fiji
Kiribati
Marshall Islands
Nauru
Niue
Palau
Papua New Guinea
Samoa
Solomon Islands
Tonga
Tuvalu
Vanuatu
7.88
0.09
7.72
13.32
10.02
0.07
6.62
3.43
92.45
11.98
6.10
10.54
3.14
2.67
Percentage
change in
imports from
rest of world
-0.53
0.00
0.22
-2.58
0.07
0.01
-0.13
0.00
-0.34
-1.04
0.16
-0.11
0.27
2.58
Percentage
change
in
exports
Percentage
change in
tariff
revenue
Percentage
change in
total
employment
Change in
welfare as a
percentage
of GDP
1.36
0.01
0.14
14.71
0.49
0.00
8.81
0.01
0.04
4.73
0.46
1.75
6.94
5.06
-11.24
-0.01
-0.40
-21.87
-0.93
-3.55
-9.09
-0.20
-0.72
-14.99
-3.41
-7.40
-21.40
-28.54
0.26
0.00
0.31
0.80
0.34
0.01
1.22
0.00
0.05
0.66
0.43
0.59
1.06
1.95
-0.19
0.00
0.23
-1.87
0.15
0.02
0.13
0.00
0.03
-0.68
0.20
0.01
-0.01
0.21
4.00
30.27
11.49
16.32
-31.63
-37.00
-32.33
-38.61
1.90
3.82
2.54
3.27
0.60
0.45
0.16
1.16
Additional simulations: reduction of rest-of-world tariff by 25%
Cook Islands
Kiribati
Samoa
Tuvalu
20
5.97
10.66
9.76
3.08
1.44
2.34
2.92
1.39
Table 3. Summary of results for FIC Free Trade scenarios
All countries: estimated changes in economic welfare as a percentage of GDP
FIC free trade area
Unemployment
Full
employment
Cook Islands
Federated States of Micronesia
Fiji
Kiribati
Marshall Islands
Nauru
Niue
Palau
Papua New Guinea
Samoa
Solomon Islands
Tonga
Tuvalu
Vanuatu
-0.19
0.00
0.23
-1.87
0.15
0.02
0.13
0.00
0.03
-0.68
0.20
0.01
-0.02
0.21
-0.30
0.00
0.12
-2.29
-0.07
0.00
-0.40
0.00
0.00
-0.84
-0.03
-0.25
-0.54
-0.42
A fuller description of the modelling process
and its unavoidable limitations is given in appendix 3.
One of the many difficulties was the
shortage and in many cases almost complete
absence of reliable labour market data, or sometimes even of any labour market data at all.
Nevertheless, it seemed clear from examination of the evidence available, including detailed interviews with responsible officials, that
considerable underemployment exists in the
FICs, particularly in the subsistence sector. In
view of this, it seemed inappropriate to use the
full employment assumption typically used in
CGE modelling, which implies that increases
in overall labour demand can be reflected only
in wage increases. An assumption at the other
extreme would be that the level of unemployment or underemployment is such that increases
in labour demand could be accommodated
through increases in employment, without any
need for wages to rise. In the absence of any
reliable data on which an intermediate scenario
could be based, these two cases, which represent opposite ends of the spectrum of possible
FIC free trade area With
Australia and New Zealand
Unemployment
Full
employment
2.61
0.03
3.27
2.83
1.05
0.06
2.18
0.21
1.32
1.06
3.29
1.73
0.90
-0.22
0.00
0.08
-1.75
-0.07
0.00
-0.39
0.01
0.06
-0.55
0.03
-0.15
-0.31
MFN liberalization
Unemployment
Full
employment
3.44
0.41
3.30
7.15
6.65
0.06
4.59
1.14
2.61
3.32
5.25
3.24
5.09
4.22
0.14
0.00
0.09
1.80
0.36
0.00
0.21
0.03
0.16
0.96
0.24
0.39
0.19
1.07
assumptions, were the two scenarios modelled.
It could be hypothesized that reality might lie
closer to the “unemployment” end of the spectrum in the case of a FIC FTA, where the effects on trade and production structures would
be relatively small, and progressively closer to
the “full employment end” of the spectrum as
the scope of the liberalization being modelled
increases. There is simply no way of being
more precise than that.
Given the limitations of the results as
outlined above, it would be unwise to base any
conclusions too heavily upon them. They are,
however, interesting and useful for the broad
corroboration they provide for a number of
hypotheses based on the standard analysis of
FTAs in the light of the economic characteristics of the FICs and their trade.
In the simulations reported in Scollay
(1998) for the “unemployment” scenario, which
was taken as the “base case”, the following are
the principal features of the results as shown
in table 2:
21
•
All FICs increase imports from other FICs,
which may be some indication of trade
creation (note that the high percentage increases in some cases can give a misleading impression, since these increases are
generally from a very low base).
•
Imports from the rest of the world also increase for half the FICs, and the percentages of both increases and decreases are
very small, which suggests that trade diversion may not be as great a problem as
might have been feared.
•
Exports rise is all cases (except one, where
they remain constant).
•
Employment rises in all cases.
•
As expected, there are tariff revenue losses
in all cases, and in five cases the loss is
moderately severe.
an FTA.
The comparison of the three different
cases in table 3 is also interesting for the confirmation it provides of earlier hypotheses.
While the “full employment” scenarios consistently produce less favourable results (as might
be expected), a clear hierarchy emerges under
both scenarios. For almost every FIC the welfare gains increase (and in most cases increase
significantly) as the coverage of the tariff removal widens from a FIC-only FTA to an FTA
including Australia and New Zealand, and finally to full MFN liberalization.
A. Conclusions
•
All but four FICs experience increases in
welfare, but the changes in welfare are generally small (in all but two cases amounting to 0.2 per cent of GDP or less).
Scollay (1998) provides some comment
on whether the projected increases in trade between FICs are realistic. Although it is impossible to validate the results of the simulations
in full, a number of examples of potential increased trade are identified.
In the cases of the four FICs experiencing welfare losses under the initial simulations,
as an experiment a further simulation was run
in which external (MFN) tariffs were reduced
by 25 per cent simultaneously with the formation of the FTA. The results of these simulations
are also shown in table 2. In each case, this 25
per cent MFN tariff reduction was sufficient to
convert the welfare losses into welfare gains,
and furthermore, in each case also reductions
in imports from the rest of the world are converted into increases. This provided striking
confirmation of the importance of ingoing MFN
liberalization in parallel with any move to form
22
The analysis reported so far allows some
fairly clear conclusions to be drawn about the
proposal for a FIC-only FTA:
•
The economic effects are likely to be very
small, and may be negative for some FICs.
•
It is critically important that MFN liberalization be continued in parallel with the
establishment of the FTA. This will avert
the possibility of negative welfare effects
and enhance the size of likely positive welfare effects.
•
The economic benefits are not likely to be
sufficient to justify a FIC-only FTA as an
ultimate objective of economic policy.
Greater welfare gains are potentially attainable through more comprehensive liberalization.
•
Some FICs will experience significant
losses of tariff revenue even under a FIConly FTA. The losses will be much greater
under an FTA including Australia and New
Zealand, and greater still under full MFN
liberalization by the FICs.
•
A FIC-only FTA may therefore have value
as an initial step in a liberalization strategy, requiring relatively modest adjust-
ments, and allowing time for the more farreaching adjustments to be put in place
which will be needed to accommodate
more comprehensive liberalization initiatives.
•
A FIC FTA should be supported by a strong
programme of trade and investment facilitation measures, especially in the quarantine and customs areas. The gains from this
may be as significant as, or more significant than, the gains from removing tariffs
between members.
A further conclusion is that if a decision is made to proceed with a FIC FTA, it
should be designed so as to minimize negotiat-
ing and administration costs, otherwise these
costs will be very likely to outweigh the relatively minor economic benefits likely to come
from the arrangement. Scollay (1998) strongly
recommends a “negative list” approach
whereby trade is liberalized in all products except for a (preferably short) list of exclusions.
This is contrasted with the “positive list” or
“product-by-product” approach often used in
the negotiation of FTAs between developing
countries, which tends to be very intensive in
the use of negotiating and administrative resources. Under the “positive list” approach,
furthermore, experience shows that progress in
removing trade barriers often slows down quite
rapidly as the negotiations widen to take in increasingly sensitive products.
23
IV.
THE FIC FTA PROPOSAL
The decision by FIC leaders to proceed
with negotiation of a FIC FTA indicates that
they accepted the argument outlined in Laird
(1999) that the smaller immediate gains from
such an arrangement are an acceptable price to
pay to keep initial adjustment costs within tolerable limits. In particular, the FICs appear to
have endorsed a “stepping stone” approach
whereby a small initial step allows collective
liberalization to move forward while allowing
time to prepare for the adjustments likely to
accompany subsequent larger steps. The establishment of a FIC FTA as an initial step also
serves a “confidence building” and “capacity
building” function, providing an initial low-cost
taste of the benefits of liberalization, and experience in the negotiation and management of
trade agreements, thus helping to develop confidence and capacity to engage in further joint
liberalization initiatives. Political considerations were also clearly important, notably the
perceived need to provide a greater sense of
solidarity among the FICs in international trade
policy matters. This was seen as an important
counterweight both to the variable participation of FICs in most of their trade agreements
with developed countries, and to the tendency
to form trade coalitions on ethnocentric lines
as reflected in the emergence of the Melanesian
Spearhead Group trade agreement.
A draft negotiating text for a FIC Free
Trade Agreement has been prepared (Myburgh,
1999). Its principal features are:
•
Tariffs are to be phased out over 10 years
on an automatic timetabled basis.
•
The approach to non-tariff barriers is that
they are to be eliminated as and when they
are identified, if necessary through
24
tariffication. This approach was considered preferable to spending resources on
developing and negotiating detailed rules
to address a problem which is considered
to be minor.
•
A “negative list” approach is adopted, with
provisions to limit the size of negative lists
and gradually phase them out.
•
Rules of origin are not product-specific and
provide exporters with the option of using
the “change of customs heading” (CCH)
basis or a 40 per cent area content rule.
•
“Emergency actions” (anti-dumping and
countervailing measures, safeguard and
balance-of-payment measures) are allowed
under strict conditions.
•
An “infant industry” provision permits suspension of the agreement for nominated
products to allow “infant industries” to develop, again under strict conditions, including an automatic lapsing of the suspension
if the development does not proceed within
a stated time frame.
•
Principles for conduct of government procurement are included, although their implementation is non-binding and on a “best
efforts” basis.
•
There is a three-stage dispute settlement
process, progressing from consultation to
mediation to arbitration.
•
The operation of the agreement is to be
reviewed after five years, and at regular intervals thereafter.
The key considerations in these design
features are, first, to minimize negotiating and
administrative costs so that these offset any
positive welfare effects as little as possible, as
explained above. This is reflected in the automaticity built in to the tariff reduction schedules and especially in the adoption of a “negative list” approach. Second, the provisions on
emergency actions and infant industries reflect
the vulnerability of the FICs and the need to
provide for the possible future evolution of their
development strategies. The provisions are intended to ensure that the FICs have sufficient
flexibility to deal with unusually severe economic disturbances and to implement fresh
development initiatives that may be proposed
in future, while at the same time providing sufficient disciplines to ensure that this flexibility
is not used to undermine the agreement by reintroducing unjustified protection on a discretionary basis. Third, it is intended that the
agreement will as far as possible meet the standards laid down in GATT Article XXIV. Fourth,
and relatedly, the agreement is designed as a
genuine trade liberalization initiative, and this
is reflected in its wide coverage, the relatively
liberal rules of origin, and the automaticity of
its provisions.
The economic arguments in favour of
this last point are not necessarily clear-cut.
Laird (1999) points out that in the case of a
trade-diverting agreement it might be preferable to keep its coverage as narrow as possible
in order to minimize the economic damage –
and there are some grounds to be concerned
about possible trade diversion in a FIC FTA,
as noted earlier. However, since a FIC FTA is
regarded as no more than a step in what is intended to be a more comprehensive liberalization process, it was felt that the arguments in
favour of wide coverage should prevail. It was
also considered that this could not be regarded
as a threat to the development process in the
FICs, in view of their very narrow production
base, which means that there are relatively few
industries or potential industries which will be
put under pressure by the dismantling of protection. These relatively few cases can be readily accommodated under the “negative list” provisions.
Following completion of the negotiations for establishment of a FIC FTA, it is envisaged that detailed proposals will be developed and implemented for trade facilitation
measures to accompany the FTA, particularly
in the quarantine and customs areas. Extension of the agreement to cover trade in services has already been mooted, and the FICs have
indicated a firm interest in extending the agreement to include the French and United States
Pacific territories.1 Studies on both the latter
issues are being commissioned.
1
New Caledonia, French Polynesia, and Wallis and
Futuna; Guam, Commonwealth of the Northern Mariana
Islands, American Samoa.
25
V.
LINKS TO PREFERENTIAL ARRANGEMENTS WITH
DEVELOPED COUNTRY PARTNERS
The World Bank (2000) has suggested
that developing countries may be better served
by entering into RTAs with developed countries rather than with other developing countries. However, the proposed FIC FTA is not
an isolated venture into preferential trade on
the part of the FICs. The FICs already have
largely unrestricted and non-reciprocal dutyfree access to both the Australian and New
Zealand markets under SPARTECA and to the
European Union market under the Lomé Convention. The Federated States of Micronesia,
the Marshall Islands and Palau (the “compact
countries”) have similar access to the United
States market under the CFA. Furthermore, the
FICs are facing what may turn out to be irresistible pressures to convert existing non-reciprocal preferential arrangements with developed
countries into reciprocal arrangements.
The European Union, as is well known,
and as noted earlier in this paper, has proposed
that the non-reciprocal preferential access arrangements extended over many years through
the trade provisions of the Lomé Convention
should be replaced by reciprocal market access
provisions to be embodied in a series of Regional Economic Partnership Agreements
(REPAs), which it plans to sign with groups of
countries in the ACP regions. The Cotonou
Agreement, signed in mid-2000, replaces the
Lomé Convention and provides for negotiations
on REPAs, or alternatives which might be proposed by the ACP States and accepted by the
European Union, to begin in 2002, with implementation to begin in 2008. Australia and New
Zealand have clearly indicated that as full members of the Pacific Islands Forum they expect
to be included in the FIC FTA as full members, and the Forum leaders have in fact agreed
that a formula must be found which provides
26
appropriate “application of the [FIC FTA]
measures to Australia and New Zealand”; these
need not imply full membership, however. Inclusion of Australia and New Zealand in an
FTA with the FICs may trigger provisions in
the Lomé Convention requiring that the FICs
do not grant any other developed country
greater market access than they grant to the European Union, as well as similar provision in
the CFA with the United States for the three
former United States trust territories. If the FICs
grant preferential access to the European Union or the United States there is no formal legal requirement to grant equivalent access to
Australia and New Zealand, but the politics of
the situation are such, given the latter two countries’ position as full members of (and also the
major donors to) the Pacific Islands Forum, that
the granting of such access would almost certainly be unavoidable.
The design of new agreements to accommodate all these considerations, while at
the same time meeting the non-discrimination
provisions of the GATT and the relevant GATT/
WTO rules on RTAs, raises many difficult issues. Some of the difficulties would be lessened if a FIC RTA was established as a customs union, with a common external tariff, thus
making it easier for the FICs to enter new trade
agreements as a group. A customs union is,
however, unlikely in the foreseeable future. The
issues involved in the design of the new agreements are beyond the scope of this paper, and
will not be discussed further here.
The proposed FIC FTA will thus be just
one element in an interconnected web of preferential trade arrangements in which the FICs
are involved. The web is developing in ways
which will obviate any disadvantage the FICs
might have suffered from not opening up their
markets to developed country partners, and
which in the process will of course also serve
to further neutralize any further trade-diverting effects of a FIC FTA. The FIC FTA proposal also raises questions about how it will fit
into the overall architecture of trading arrangements in which the FICs are involved.
A FIC-only FTA causes relatively few
complications. It could be notified under the
“Enabling Clause” to the Trade and Development Committee of the WTO, where it might
expect an easy passage. The FICs would be
left free to negotiate new agreements with their
major developed country partners independently of the provisions of the FIC FTA, although
they may wish to suggest that some provisions
of the FIC FTA be used as a model for these
agreements – other things being equal, it is
clearly in the FICs’ interests to standardize as
far as possible the provisions of the preferential agreements in which they are involved (except where differences are required in order to
take account of development considerations),
so as to minimize the administrative complexities involved.
An FTA which includes Australia and
New Zealand, on the other hand will have to
notified under Article XXIV and examined by
the Committee on Regional Trade Agreements,
where it will be subject to more rigorous scrutiny, and where a number of potential difficulties in terms of Article XXIV may be raised.
The market access provisions of the Lomé
Convention and the CFA would in this case
inevitably ensure that the negotiation and development of the FTA would become linked to
the FICs’ negotiations with the European Union and the United States. If Australia and New
Zealand are not included as full members of
the FTA, an alternative formula for linking them
to the provisions of the FTA will have to be
found, both to satisfy the mandate from Forum
leaders and to accommodate the political reality that Australia and New Zealand are bound
to demand treatment equivalent to any market
access granted to the European Union in forth-
coming negotiations.
Regardless of the architecture adopted,
it seems likely, in view of the legal claims and/
or likely politically irresistible demands of the
major developed country economic partners for
equivalent treatment in terms of market access,
that the FICs will have to contemplate simultaneously opening up their markets to Australia
and New Zealand, the European Union and the
United States – and possibly also Japan, given
that that country, a major aid donor in the region, is unlikely to take kindly to discrimination against it in favour of other developed
countries. In other words, in terms of the “stepping stone” approach to liberalization, the step
after a FIC FTA is likely to have to be a very
large one, moving the FICs a considerable part
of the way towards full MFN liberalization.
The previous discussion suggests that a
large second “step” of this nature would have
a positive effect on the welfare gains from preferential liberalization, since it would help to
counter the trade diversion that might arise not
only in an FTA among the FICs but also if the
FICs granted preferential access to only one of
their developed country trading partners.
Panagariya (1999) provides some grounds for
apprehension about the latter possibility by
outlining a set of conditions under which a
small high-tariff country might suffer particularly large economic losses in an RTA with a
larger low-tariff country. This could occur if
the larger country failed to fully displace imports from other sources in the smaller country’s market, and if under these conditions the
price of imports did not fall. In this case, the
exporters in the larger country “capture” the
tariff revenue previously received by the
smaller country’s Government. The disparate
size of the partners means that this loss will
not be offset by a similar effect operating on
trade in the other direction. The potential dangers of a situation such as this are avoided if
preferential access is simultaneously granted
to each of the main sources of imports.
27
However, while a larger second “step”
may be positive for the welfare gains from trade
liberalization, it also implies a correspondingly
larger adjustment, particularly in terms of the
need to provide for alternative sources of revenue to replace the lost tariff revenue. This is
likely to affect the length of the time frame
within which the FICs are prepared to contemplate taking this second step.
28
The FICs clearly face a major challenge
in managing interlinked negotiations with their
major developed country economic partners in
such a way that they retain control over the pace
of their own liberalization, ensure that the resulting agreements do not involve them in unnecessary complexities or administrative burdens, and at the same time secure an acceptable level of compensation for the additional
market access they will be compelled to offer.
VI.
CONCLUSION
If the proposed FIC FTA is taken out of
context it can easily be presented as an initiative which makes little economic sense. Taken,
however, in the context of the economic characteristics of the FICs and the trade policy issues which they face, it can be viewed as a small
but useful element in an ongoing strategy of
trade liberalization. An understanding of the
implications of a FIC FTA, furthermore, requires an assessment of the ways in which it
may be linked to the trade negotiations which
the FICs will be obliged to conduct with their
major developed country economic partners.
29
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Bhagwati, J., D. Greenaway and A. Panagariya (1998), “Trading Preferentially: Theory and
Policy”, Economic Journal 108, 1128–1148.
Bhagwati J. and A. Panagariya (1996), ”Preferential Trading Areas and Multilateralism: Strangers, Friends or Foes?”, in J. de Melo and A. Panagariya (eds.), New Dimensions in Regional
Integration (Cambridge, Cambridge University Press).
Commission of the European Communities (1997), Guidelines for the Negotiation of New Cooperation Agreements with the African, Caribbean and Pacific (ACP) Countries (Brussels).
Ethier, W. (1998), “The New Regionalism”, Economic Journal 108, 1149–1161.
Grynberg, R. and T.T. Kabutaulaka (1995), “The Political Economy of Melanesian Trade Integration”, Pacific Economic Bulletin, 48–60.
Kemp, M.C. and H. Wan (1976), “An Elementary Proposition Concerning the Formation of
Customs Unions”, Journal of International Economics 6, 95–98
Krugman, P. (1991), “The Move to Free Trade Zones”, Federal Reserve Bank of Kansas City
Economic Review, November/December, 5–25.
Laird, S. (1999), “Regional Trade Agreements: Dangerous Liaisons?, World Economy 22, 1179–
1200
Lawrence, R. (1997), Regionalism, Multilateralism and Deeper Integration (Washington, D.C.,
Brookings Institution).
McMillan, J. 1993, “Does Regional Integration Foster Open Trade? Economic Theory and
GATT’s Article XXIV”, in K. Anderson and R. Blackhurst (eds.), Regional Integration and
the Global Trading System (London, Harvester Wheatsheaf).
Myburgh, P. (1999), Pacific Regional Trade Agreement (PARTA) and Protocols: Draft Negotiating Text 1.0 (Suva, South Pacific Forum Secretariat).
Panagariya, A. (1998), “Do Transport Costs Justify Regional Preferential Trade Arrangements?
No”, Weltwirtschaftliches Archiv 134, 280–301.
Panagariya, A. (1999), “The Regionalism Debate: An Overview”, World Economy 22, 477–511.
30
Scollay, R. (1998), Free Trade Options for the Forum Island Countries (Suva, South Pacific
Forum Secretariat).
Scollay, R. and J. Gilbert (1998), MFN (Non-Preferential) Liberalisation by Forum Island Countries: Commentary on CGE Analysis of Economic Effects (Suva, South Pacific Forum Secretariat).
South Pacific Forum Secretariat (1996), Tariff Policy in Forum Island Countries (Suva).
Stoeckel, A. et al. (1998), Costs and Benefits of a Free Trade Area between the Forum Island
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Viner, J. (1950), The Customs Union Issue (New York, Carnegie Endowment for International
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WTO (2000), Mapping of Regional Trade Agreements: Note by the Secretariat (Geneva).
31
APPENDIXES
33
APPENDIX 1
Economic characteristics of the FICs: GDP,
per capita GDP, and population
Nominal GDP
(US$ million)
Cook Islands
Federated States of Micronesia
Fiji
Kiribati
Marshall Islands
Nauru
Niue
Palau
Papua New Guinea
Samoa
Solomon Islands
Tonga
Tuvalu
Vanuatu
GDP per capita
(US$)
Population
(000)
5 269
1 976
2 565
651
1 738
3 355
3 522
8 204
1 239
1 037
720
1 492
1 107
1 411
18.8
109.2
772.7
78.5
58.7
11.2
2.5
17.7
414.8
169.0
395.2
99.0
9.5
168.4
99.3
215.8
1 981.6
51.1
102.1
35.9
8.1
145.1
5 130.8
175.3
284.5
145.4
11.1
237.6
Sources: National economic data.
APPENDIX 2
TARIFFS FIC
Tariffs
as % of imports
Cook Islands
Federated States of Micronesia
Fiji
Kiribati
Marshall Islands
Nauru
Niue
Palau
Papua New Guinea
Samoa
Solomon Islands
Tonga
Tuvalu
Vanuatu
34
11
1
14
28
9
0
9
5
22
12
18
13
29
Tariffs
as % of tax revenue
Tariffs
as % of total revenue
24.0
32.8
64.1
35.3
1.0
3.3
21.9
22.2
23.7
0.0
20.0
22.3
34.0
23.7
30.7
45.8
57.5
5.0
18.0
16.4
14.3
21.2
6.7
48.1
APPENDIX 3
Notes on CGE modelling and results reported in Scollay (1998)
An economy-wide or general equilibrium analysis is needed to capture the full extent of the costs and benefits of establishing a
preferential trading arrangement. This is because the removal of trade barriers changes the
relative prices within an economy, and this can
give rise to changes in resource allocation
throughout the economy. Increases in output
and employment in one sector, for example,
may be offset by decreases in another, since
the resources needed to increase output must
come from somewhere. An analysis which
focuses only on the sector directly affected by
the removal of trade barriers is therefore likely
to overstate, or in some cases understate, the
effect of the change.
Similarly, changes in trade between the
FICs arising from establishment of a preferential free trade area do not occur in a vacuum.
Trade with third countries will also be affected.
An increase in income brought about by establishment of the free trade area, for example,
will act to increase imports from third countries. On the other hand, trade diversion caused
by the preferences provided for FIC exports will
act to reduce imports from third countries, and
represents an important potential cost of a preferential free trade area, as discussed in this paper. Effects on trade with both members and
non-members must therefore be taken into account in arriving at an assessment of the costs
and benefits of preferential free trade. Once
again, an economy-wide or general equilibrium
analysis is needed to capture these effects.
A computable general equilibrium
(CGE) analysis of the effects of preferential free
trade was therefore undertaken. The procedure
is to construct a simplified model of each
economy, consisting of a set of equations designed to capture the key characteristics of the
economy and its overseas trade. The models
embody the best available information on the
structure of each economy, together with standard economic assumptions relating to the way
in which economic behaviour responds to relative price changes. Production, trade and tariff
data collected from each FIC were inserted into
the model. The model was then used to simulate the effect of the preferential removal of all
tariffs on imports from FICs, leaving tariffs
unchanged on imports from all other countries.
For simplicity, the tariff removal was modelled
as a “once-and-for all” change, whereas the
likelihood is that in practice it would be phased
in over time. The analysis models the adjustment of each economy to the tariff change, assuming all other factors affecting the economy
are held constant, and without regard to how
the adjustment might be spread over time.
Primarily because of data limitations
each economy is broken down into only a small
number of sectors. For most FICs four sectors
are used: primary production, manufacturing,
traded services and non-traded services.
Greater data availability allowed a larger
number of sectors to be used in the cases of
Papua New Guinea (eight sectors), Fiji (seven
sectors) and Vanuatu (six sectors).
The removal of tariffs was also modelled at an aggregate level. The ratio of total
tariff revenue to total import values was taken
as the best indication of average tariff rates.
This produced a lower estimate than might be
expected on the basis of published tariff rates,
in part because of the large number of tariff
exemptions granted in some FICs. Even allowing for this factor, however, the average
tariff calculated in this way must be regarded
as an underestimate of the average level of protection, since it takes no account of the extent
to which potential trade is inhibited or prevented from occurring by prohibitive tariffs.
35
Removal of tariffs on trade between
FICs was the only change considered in the
analysis. The results therefore reflect only the
effects of the relative price changes brought
about by removing tariffs. They do not capture any of the other potential effects of creating a free trade area. In the model the effect of
removing the tariff is divided between a reduction in the price at which goods from individual
FICs are sold in other FIC markets, and an increase in the price which FIC producers receive
for their exports to other FICs.
The analysis was conducted under two
separate scenarios. In the first scenario the
existence of substantial unemployment prior to
the tariff change was assumed. This means that
some sectors in the economy can expand without needing to attract labour from other sectors, so that the wage level remains unchanged.
In the second scenario full employment was
assumed, which means that expanding sectors
need to attract labour from other sectors, which
in turn means that the wage level must increase.
In many FICs official estimates of unemployment are not available. However, careful questioning about the employment situation
during consultations often produced comments
to the effect that substantial unemployment did
in fact exist, or that labour could be attracted
from the informal sector relatively easily with
little impact on wages or informal sector output. In a number of FICs moves are under way
to reduce the size of the public sector, and ample scope was considered to exist for resources
to be released from the public sector into the
private sector. Where unemployment statistics
are available, they do indicate substantial levels of unemployment, as in Fiji, where the
measured unemployment rate was 6 per cent
in 1996, and in Tuvalu, where it was 13 per
cent in 1994.
Taking this evidence into account, it is
considered that the scenario assuming substantial unemployment prior to the tariff change
provides the most realistic basis for the analysis, particularly since only a small proportion
36
of the FICs’ trade will be affected by the tariff
change. Alternative results under the scenario
assuming full employment are presented for
comparison purposes. These produce consistently less favourable welfare effects, as would
be expected.
In addition to the standard caveats regarding the interpretation of CGE modelling
results, there are several important limitations
of the analysis in Scollay (1998) which need to
be taken into account in evaluating the results
of that study. The very high level of aggregation in the models, with each economy broken
down into only a small number of sectors,
means that they cannot capture the full diversity of the economy’s likely response at the level
of individual products or even industries, particularly as the average tariff reduction is assumed to apply across all imports. For some
products and/or industries the effects will be
much more pronounced than the model results
indicate, while for others the effects will be less
pronounced. There are likely to be special factors applying in some industries which would
affect their response to a tariff change, but these
cannot be detected in the models. A more detailed study of individual economies is needed
in order to identify these differences.
The most important limitations are perhaps those relating to data sources. Because a
consistent approach was considered desirable,
the same type of data was used in modelling
each economy. There was, however, considerable diversity in the quality and coverage of
the data obtained from individual FIC economies. In some cases inconsistencies in the data
had to be removed, and in other cases “ad hoc”
assumptions had to be made to fill gaps in the
coverage of the data. During consultations it
was sometimes suggested that the official trade
data used in the modelling exercise might be
questionable. The quality of labour market data
available in the FIC economies was generally
poor, and in some cases extremely poor.
While it is reassuring that the results
obtained were reasonably consistent across all
the FICs, the limitations outlined above are such
that these results should be taken as indicative
only. It would be unwise to rely on them for
more than an indication of the direction and
order of magnitude of the economic effects of
forming a free trade area among the FICs.
Further technical details on the models
used can be found in Scollay (1998).
37
APPENDIX 4
FIC exports and imports by destination and source
Cook Islands' exports by destination,
1995
Fiji
0%
Other
14%
New Zealand
26%
Japan
15%
Cook Islands' imports by source, 1995
Australia
7.2%
Fiji
10.8%
USA
24%
Australia
21%
Federated states of Micronesia's exports
by destination, 1995
Other
2%
New Zealand
70.9%
Federated states of Micronesia's imports
by source, 1995
Marshall Is
0.1%
USA
8%
Other
14.3%
Guam
13%
Australia
2.6%
USA
39.6%
Japan
14.9%
Japan
77%
38
USA Japan
Other
3.5% 2.9%
4.7%
Guam
28.5%
Fiji's exports by destination, 1995
New Zealand
Malaysia 5%
Fiji's imports by source, 1995
FICs
4%
5%
Japan
7%
EU FICs
4.7% 0.4%
USA
7.1%
Australia
26%
Australia
38.8%
Singapore
7.1%
Japan
7.2%
USA
13%
Other
16%
Other
18.8%
EU
24%
New Zealand
15.9%
Kiribati's exports by destination, 1996
Kiribati's imports by source, 1996
N.Z.
2% Other FICs
Marshall Is
1%
3%
Australia
7%
Other
7.3%
Other
8%
China
5.9%
USA
4.2%
Other FICs
1.6%
New
Zealand
8.2%
Hong
Kong
8%
EU
58%
USA
13%
Japan
8.5%
Fiji
18.4%
Australia
45.8%
39
Marshall Islands' imports by source, 1995
Japan
7.4%
Australia
1.9%
FICs
1.0%
Guam
14.6%
USA
51.1%
Other
24.0%
Nauru's exports by destination
FICs
0.3%
Other
99.7%
40
Nauru's imports by source, 1997
Japan
5%
FICs
2%
Other
1%
Australia
92%
Niue's exports by destination, 1995
Niue's imports by source, 1995
Fiji
2.3%
Fiji
9.0%
New Zealand
97.7%
New Zealand
91.0%
Papua New Guinea's imports by source,
1997
Papua New Guinea's exports by
destination, 1997
FICs
1%
Other
32%
Australia
26%
Other
11.5%
Australia
51.6%
Singapore
11.4%
New
Zealand
0%
Philippines
3%
Rep. of Korea
4%
FICs
0.9%
Japan
17%
USA
2%
EU
15%
USA
6.8%
EU
4.2%
Japan
9.1% New Zealand
4.4%
41
Samoa's imports by source, 1996
Samoa's exports by destination, 1996
Australia
9.2%
Other
6.8%
FICs
3.3%
Other
12.6%
New
Zealand
48.1%
USA
12.8%
American
Samoa
15.3%
New Zealand
38.3%
Fiji
14.2%
EU
17.3%
Australia
22.1%
Solomon Islands' exports by destination,
1995
Rep. of
Korea
15%
Australia
2%
FICs
EU
3.5%
China
3.5%
3.6%
FICs
2%
Japan
37%
Thailand
3.4%
New
Zealand
8.9%
Singapore
9.3%
Other
19%
EU
25%
42
Solomon Islands' imports by source, 1995
Japan
11.8%
Other
15.0%
Australia
41.0%
Tonga's exports by destination, 1996
Australia
American 3.7%
Samoa
3.8%
Fiji
4%
Tonga's imports by source, 1996
EU China
2.3% 1.2%
Other
FICs
0.3%
Japan
49%
Other
6%
New
Zealand
15%
Japan
6.9%
Other
4.0%
New
Zealand
37.5%
Fiji
7.1%
USA
11.3%
USA
18%
Australia
29.7%
Vanuatu's exports by destination, 1996
FICs
4.5%
Other FICs
0.1%
New
Caledonia Australia
4.4%
3.5%
New
Zealand
1.8%
Fiji
7%
Bangladesh
30.9%
Rep. of
Korea
6.0%
Other
11.1%
Vanuatu's imports by source, 1996
Japan
5%
Hong Kong
3.0%
Other
FICs
2.0%
Australia
44%
New
Caledonia
8%
New Zealand
12%
Japan
16.2%
EU
21.6%
Other
19%
43
UNCTAD Study Series on
POLICY ISSUES IN INTERNATIONAL TRADE
AND COMMODITIES
No. 1
Erich Supper, Is there effectively a level playing field for developing country
exports?, 2001.
No. 2
Arvind Pangariya, E-commerce, WTO and developing countries, 2000.
No. 3
Joseph Francois, Assessing the results of general equilibrium studies of multilateral trade negotiations, 2000.
No. 4
John Whalley, What can the developing countries infer from the Uruguay
Round models for future negotiations?, 2000.
No. 5
Susan Teltscher, Tariffs, taxes and electronic commerce: Revenue implications
for developing countries, 2000.
No. 6
Bijit Bora, Peter J. Lloyd, Mari Pangestu, Industrial policy and the WTO, 2000.
No. 7
Emilio J. Medina-Smith, Is the export-led growth hypothesis valid for developing countries? A case study of Costa Rica, 2001.
No. 8
Christopher Findlay, Service sector reform and development strategies: Issues
and research priorities, 2001.
No. 9
Inge Nora Neufeld, Anti-dumping and countervailing procedures – Use or
abuse? Implications for developing countries, 2001.
No. 10 Robert Scollay, Regional trade agreements and developing countries: The case
of the Pacific Islands’ proposed free trade agreement, 2001.
No. 11 Robert Scollay and John Gilbert, An integrated approach to agricultural trade
and development issues: Exploring the welfare and distribution issues, forthcoming.
No. 12 Marc Bacchetta and Bijit Bora, Post-Uruguay round market access barriers for
industrial products, forthcoming.
No. 13 Bijit Bora and Inge Nora Neufeld, Tariffs and the East Asian financial crisis,
forthcoming.
No. 14 Bijit Bora, Lucian Cernat, Alessandro Turrini, Duty and Quota-Free Access for
LDCs: Further Evidence from CGE Modelling, forthcoming.
No. 15 Bijit Bora, John Gilbert, Robert Scollay, Assessing regional trading arrangements in the Asia-Pacific, forthcoming.
45